The United States has almost 70 tax treaties with foreign countries covering income taxes and capital gains tax. These treaties delineate which country is entitled to tax an individual or entity in cross-border situations. But income taxes are only part of the tax burden for working individuals. Many countries, including the United States, assess social security–type taxes on their workers. This is where totalization agreements come into play.
The main purpose of totalization agreements is to eliminate dual social security coverage and to allow social security taxes to be paid to only one country (the United States or the foreign country), rather than both. Totalization agreements also help people, who at retirement age may not meet the eligibility requirements in any one country, to qualify for social security benefits by using credits earned in another country.
As we have discussed in prior blog posts, U.S. citizens and residents must file U.S. tax returns and report their worldwide income, no matter where they currently reside. A lesser-known fact is that self-employment earnings are subject to U.S. self-employment taxes even if earned overseas and even if that income is eligible for the foreign earned income exclusion or excludable under an income tax treaty provision. Here is an example of how this works:
Sarah is a U.S. citizen who is currently working abroad in Ireland, and the U.S. has a totalization agreement with Ireland. Sarah was born and grew up in the United States and worked in the United States throughout college and for two years after graduation. Sarah received credit toward her U.S. social security benefits during this time.
Not satisfied with her job situation, Sarah decided to become an au pair (nanny) in Ireland. For her au pair job, Sarah considers herself self-employed, which means she normally has to pay social security taxes to both the United States and Ireland. However, because of the totalization agreement between Ireland and the United States, she can avoid paying into both countries’ systems. Sarah must pay Irish social security taxes, but she can get a certificate of coverage from Ireland to attach to her U.S. tax return each year so that she does not have to pay U.S. self-employment taxes.
Sarah will likely be able to qualify for U.S. social security benefits if she chooses to return to the United States. The United States will acknowledge her payments into the Irish social security system so she can still receive U.S. benefits.
There are many tax implications when working abroad. If you have worked abroad, are considering working abroad, or have any other questions relating to foreign issues, we would be happy to help. Please reach out to us and set up an appointment today.
By Kimberly Miller